The Cacophony Of Markets
Via Mark Grant, author of Out of the Box,
The Rhapsody of the Markets
Recently I was on CNBC and Steve Liesman, who I know personally and is a very thoughtful fellow, made the comment that I had called the events right but I had not gotten the market right. It was a fair remark as related to the stock market. My reply was that while I thought that he was correct about the stock market that I thought I had been correct about the bond market which was leading the way and that the stock markets would catch up. Since then I have given our conversation some more thought.
In Quantum Mechanics there is what is called the “string theory.” Without a great deal of complicated explanation the concept is that the strings vibrate and the more they vibrate the more they are drawn together. This is a decent analogy for the financial markets. As events get more tense or there are “moments” the markets vibrate more wildly and the equity markets in Europe, Asia and the United States begin to move more in tandem; they are drawn together. The same can be said of the equity and the bond markets; as more excitement of one kind or another occurs the more the debt and equity markets move in the same direction. Conversely when things are calm and the world is peaceful the markets vibrate less and spread apart and move on the basis of their own fundamentals and technicals.
Generally, not always but I would say 75% of the time the bond markets leads the stock markets. This is because of the focus of the two markets are different. Bonds are affected by world events immediately as the relative value of bonds are more tied into world markets than the American Stock market. The bond markets are also much more a function of the institutional investor than the retail investor so they react more quickly. Around nine months ago I called for a 10 year Treasury at 1.25% and we are but a scant 34 basis points away from that now. The Treasury market is indicating a worsening financial condition and more risk while the equity markets are dancing along as if they are immune from world events. It often takes awhile but I think the equity markets will catch up in due course.
Actually the stock markets are confronted with two major dilemmas that I think will cause their decline. The first is Europe and their “moments.” While everyone waits to see if we have a “Lehman moment” or a huge systemic event we have certainly had “moments.” We have had two “Greek moments,” an “Irish moment,” a “Portuguese moment,” a “Cyprus moment” a “Spanish moment” and now we are about to get a “Slovenia moment.” This would be seven out of the seventeen economies that belong to the European Union that need to be bailed out. This is 41% of the Euro-17 that is in trouble. The second indication of decline is the recessions in Europe. In fact virtually all of Europe is in a recession and while Germany has held its head above the water I think by the third or fourth quarter that she is also mired in an economic decline. Europe is 25% of the global economy and this is beginning to affect the United States as exemplified by the declining revenues and profits of many American corporations that have so far reported out this quarter. The axes of the financial markets are America, Europe and China and with Europe in serious decline and China also contracting the strings are vibrating so that all of the markets are likely to go down.
I would also like to point out the difference between the American financial crisis and the European one. We had a long time line of easy money and normalized mortgage and mortgage securitization prices. Then we hit the wall with Bear Stearns and Lehman and the dam burst. This was, in part, because no one was expecting it and very few, initially, understood the implications of these two events. The European crisis has also had a long time line to date. We have had many of these “moments” but ones that were somewhat expected and so the surprise/fear factor has not been heightened yet and so the strings quiver and then calm down but nothing yet has sent them into financial shock. The “Greece (3) moment” has the potential to do so if the Troika reports out the expected disaster and then debt forgiveness is not politically possible and the IMF/EU refuses funding and the country defaults. The total amount of debt is $1.3 trillion and if Europe believes its own nonsense and Greece does default then you may expect a “systemic moment.”
Even without some cataclysmic shock, realization is coming. The debts of Europe are being paid off with ever more debt and the can kicking will find its walls and as the European recession deepens it will be felt in America and then adjustments will have to be made. I do not make the call for a trade but declining financials are coming; both for corporations and for our GDP and eventually the equity markets will notice. One may also expect the Euro to decline against the Dollar and 1.18 will be the next level I think. Since Oil trades in Dollars the Europeans have had an advantage as they can buy cheaper Oil than America but as the Euro recedes against the Dollar it will also fuel their recessionary decline.
Fact versus Fantasy
The EFSF Stabilization Fund is in existence, has no seniority, and after the bailout for Spain, which will go directly to the sovereign and not to the banks, will have about $250 billion left and is the only so called “Firewall” currently in existence.
The ESM, the other stabilization fund, is not in existence, is being challenged by Finland, the Netherlands and in the German courts and, while likely to come into existence, is not yet.
The ECB has said they have lowered their collateral standards while the Bundesbank has refused to do so. The German Central Bank then effectively overruled the ECB as they control the Target2 funding and have blocked the ECB by fiat.
The newly proposed European Banking Regulatory Authority is not yet in existence and will not be for between six months to a year; if ever.
The Germans will not “harmonize” European debt until this authority is in existence so that the plan is not in existence and will not be, in the best case scenario, for quite some time.
The proposed European Banking Authority would require every nation in Europe to relinquish control of their budgets and their finances to a central European authority. Not only is this politically problematical but it is constitutionally problematical in many nations including Germany. In the end, in my opinion, there will be no central regulatory body, it will not happen, so that the EU has proposed a scheme that will never be actualized as we continue to sit on square one.
There is no plan, scheme, artifice that will allow for Greece to pay off its debts. It has to be “debt forgiveness;” which has been discussed by no one or default. The odds of default are now greater than 95% which will most likely take place within the European Union and which will come after the Troika report and then when the IMF/EU refuses more aid. Greece defaults, receives some kind of debtor-in-possession financing and is forced back to the Drachma and devalues. The Prime Minister and the Finance Minister calls it a “great victory for Europe” and we get proof, once again, as first demonstrated by Spain, that there are, in fact, parallel universes. The scientific proof of parallel universes then may be the highlight of the accomplishments of the European Union for the year.
“Some may call the nations on the continent Europe. These nations, however, have engaged in so many fantastic notions recently that I prefer to name the Union in Europe; Middle Earth.”